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CVS and Caremark Rx Unveil Stock-Swap Deal

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http://online.wsj.com/article/SB116238296523810065.html

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Combined Drugstore, Benefits Manager
Would Have $75 Billion in Annual Sales

By GEORGE STAHL
November 1, 2006 2:56 p.m.

CVS Corp., one of the largest drugstore chains in the U.S., and Caremark Rx Inc., a leading pharmacy-benefits manager, unveiled a stock-swap merger valued at more than $20 billion.

Under terms of the all-stock deal, Caremark shareholders will get 1.67 shares of CVS stock for each share of Caremark they own.

The companies stressed that it is a "merger of equals," with CVS Chief Executive Tom Ryan becoming CEO of the new company and Caremark CEO Mac Crawford assuming the chairman's post. The companies said that, on a pro forma basis, CVS shareholders will own 54.5% of the combined company and Caremark shareholders will own 45.5%. The board of directors will be split evenly between representatives from Caremark and CVS.

The new company will have combined annual revenue of $75 billion. As of Tuesday's close, Caremark's market capitalization was $21.02 billion, while CVS's was $25.78 billion.

"This merger is a logical evolution for CVS, Caremark and the entire pharmacy industry," Mr. Ryan said. "Employers and health plans want to control costs, but also want their plan members to have access to a full range of integrated pharmacy services."

Headquarters in Rhode Island

The new company, to be called CVS/Caremark Corp., will be headquartered in Woonsocket, R.I., where CVS is currently based. The pharmacy-services business will be based in Nashville, Tenn., where Caremark's headquarters are. The new company is expected to fill or manage more than one billion prescriptions per year, the companies said.

The companies said they expect "operating synergies" of about $400 million and expect the deal to add to earnings in the first full year after the deal closes.

While analysts were mostly upbeat on the long-term prospects of the merger, investors didn't appear to be impressed, sending shares of both companies lower. Some analysts fretted that integrating the operations might be a burden for CVS, which already has made two large retail acquisitions this year.

In afternoon trading, Caremark shares were down 47 cents, or 1%, at $48.76, while CVS shares were down $2.18, or 7%, to $29.20, both on the New York Stock Exchange. The new company will also trade on the Big Board, under the symbol "CVS."

An Industry Powerhouse

Merging the largest pharmacy-benefits manager with one of the largest U.S. drugstore chains creates a major player in the health-care industry, with significant buying power in generic drugs and dominant positions in numbers of retail outlets and mail-order capability, an increasing component of drug distribution. UBS analyst Neil Currie said the scale could be used as a weapon to gain market share in both the PBM business and retail pharmacy.

A deal also increases CVS's access to members of Medicare's prescription drug plan, giving the drugstore the ability to market its front-end retail business directly to Caremark's members. A tie-up also will help fight off an increasing threat from Wal-Mart Stores Inc., which has cut prices on some generic drugs, threatening margins at PBMs and drugstores.

PBMs like Caremark handle prescription-drug benefits for individuals on behalf of clients, namely employers and health plans, and operate their own mail-order pharmacies.

Goldman Sachs analyst Christopher McFadden said news of the deal suggests an easing in the "traditional animosity between retailers and PBMs" in light of growth opportunities presented by the Medicare prescription-drug program and national employer contracting. [rph_in_wi: comments on this?] He also noted "signs of market maturity for the PBM sector."

Shares of drugstores chains and PBMs have declined since the middle of September from a perceived threat from Wal-Mart, which unveiled plans to cut the price on some generic drugs to $4 for a 30-day supply.

The deal could pressure drug wholesalers, specifically McKesson Corp., which gets 11% of its revenue from Caremark, and Cardinal Health Inc., which gets 21% of its revenue from CVS, according to Revere Research.

CVS Stocks Up

Caremark Rx is the largest pharmacy-benefits manager by market capitalization, providing drug-benefit services to more than 2,000 health-plan sponsors and their plan participants throughout the U.S. The company also operates a national retail-pharmacy network with more than 60,000 participating pharmacies. For the year ended Dec. 31, Caremark reported earnings of $932.4 million, or $2.05 a share, on revenue of $33 billion.

CVS is the largest drugstore chain by store count but the second largest by store sales behind Walgreen Co. CVS operates about 6,200 retail and specialty pharmacy stores in 44 states and the District of Columbia. Last month, CVS lifted its third-quarter and 2006 earnings guidance, citing September same-store sales and a "solid improvement" in gross margins. For the year ended Dec. 31, CVS reported earnings of $1.2 billion, or $1.45 a share, on sales of $37 billion.

Mr. Currie said an acquisition of Caremark provides CVS with the ability to market its front-end retail business directly to Caremark's members. He said that strategy has been successful with CVS's Pharmacare PBM, where CVS has offered front-end discounts to PBM customers.

CVS has been acquisitive this year. In June, CVS bought 700 Osco and Sav-On pharmacies from $2.93 billion and indicated then that it was in the market for more acquisitions. Mr. Ryan said at the time that he was unfazed by recent downgrades of CVS debt by credit-rating companies concerned about the amount of debt incurred as part of the drugstore chain's most recent purchase. "This is a still consolidating industry," Mr. Ryan said then. "Acquisitions are a big part of our business, and we do [them] well."

Since then, CVS bought MinuteClinic, a Minneapolis provider of retail-based health clinics in the U.S. Terms weren't disclosed. In August, Moody's Investors Service affirmed a long-term rating of Baa2 on CVS, leaving the company two steps above junk ratings. Standard & Poor's rates the company one notch higher, at BBB+.

Other drugstore chains also have made recent purchases. In August, Rite Aid Corp. agreed to purchase the Eckerd and Brooks drugstore chains from Jean Coutu Group Inc. for about $3.4 billion in cash and stock. Walgreen has bought a Delaware drugstore chain and a specialty pharmacy company this year.

CVS and Caremark are expected to report earnings and hold conference calls Thursday.
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